Summers & Coupal: The pension threat to California

June 26, 2010

Updated Aug. 21, 2013 1:17 p.m.

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By ADAM B. SUMMERS and JON COUPAL / Summers is a policy analyst at Reason Foundation and author of a new study on the state's pension crisis. Coupal is president of the Howard Jarvis Taxpayers Association

California's $19 billion budget deficit seems to worsen by the day, but an even larger financial crisis is brewing in the state's pension system. Over the past two decades, state lawmakers have bestowed hefty pension and benefit increases upon government workers. Taxpayers are now getting the bills for these handouts. Recent studies estimate California has perhaps $500 billion in unfunded pension obligations, not to mention over $50 billion in unfunded retiree health care obligations.

It's important for the state to recognize how it got into this fiscal disaster – and how to get out of it.

California's public pension and retiree health and dental care expenditures have quintupled since fiscal year 1998-99, going from about $1 billion then to $5 billion this year. And retirement spending is expected to triple again – to $15 billion – within the next decade.

Part of the problem is the growth of state government. Since 1998, California's state workforce has grown by 31 percent, and taxpayers now pay for more than 356,000 state workers. Even during this terrible recession, instead of cutting back, California has added over 13,000 workers to the state payroll since 2008.

The benefit increases doled out by Sacramento are also crushing the state. Consider that public pension benefit increases passed in 1999 via Senate Bill 400, which offered retroactive benefit increases to government workers, were supposed to cost $650 million in 2010. The actual costs of SB400 to taxpayers: $3.1 billion this fiscal year and $3.5 billion next year.

Even worse, California is the only state that calculates pension benefits based on an employee's highest salary in a single year. Most states use periods of three or five years to determine pension benefits, making their systems less susceptible to pension spiking. SB2465, which implemented the one-year final salary rule in 1990, has cost taxpayers more than $100 million a year. It was supposed to cost "only" $63 million per year.

The results are lavish pensions for government workers and big bills for taxpayers. California taxpayers are now paying pensions that exceed $100,000 a year to more than 12,000 former state and local government workers, including more than 9,000 state and local employees covered by the California Public Employees' Retirement System and over 3,000 former school administrators or teachers covered under the California State Teachers' Retirement System.

This pension crisis threatens to bankrupt the state. Gov. Arnold Schwarzenegger has urged action on this issue but current reform proposals merely tinker around the edges of the current system, known as defined benefit, and do not go nearly far enough. There are several steps California must take to permanently get pension costs under control.

The private sector long ago abandoned defined-benefit pensions, where the retiree receives a guaranteed level of payment, due to their volatility and unsustainable costs. California is going to have to do the same. Close the defined-benefit pension plans for state employees and enroll all new or future employees in 401(k)-style, defined-contribution plans for pensions and other post-employment benefits, such as retiree health care and dental benefits. These 401(k) plans are good enough for the rest of the population; they should be good enough for government workers.

To prevent the handouts and pension favors that politicians have been giving to certain groups, California should adopt an amendment to the state constitution requiring that all future government employee benefit increases be approved by voters, who foot the bills. It should also pass another amendment prohibiting retroactive benefit increases.

In the short-term, the state should also require employees who have previously retired to forfeit their retirement checks while they are on the state's payroll to avoid double-dipping and collecting multiple checks, as over 5,000 former state employees are doing today.

California's pension and retiree health care benefits are unaffordable and unsustainable. Gov. Schwarzenegger and a few politicians, from both sides of the political aisle, are now calling for action on this tremendous problem. They'd better hurry. Taxpayers are sick and tired of being forced to pay ever-greater amounts toward increasingly generous benefits for government employees, all while their own retirement accounts shrink amidst the recession. To avoid bankruptcy, governments at all levels are going to have to switch from defined-benefit pensions to more affordable 401(k)-style defined-contribution systems.

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